How Safe Are The Banks?

A stable banking sector willing to lend is critical to the growth of the U.S. economy. The near failure of many of the largest banks in the U.S. in 2008 brought the economy to the brink of depression. Since the presidential election last November, the S&P 500 financial sector ETF (XLF) is +24% and the SPDR KBW bank ETF (KBE) is +30%. The continued growth of the economy and stock market is contingent on a healthy banking sector.

In 2016, five FDIC insured banks failed. This was the lowest level since 2007. Shown below is a chart of bank failures by year since the founding of the FDIC in 1933.

For historical perspective, in the years before the FDIC became operational, it was common for more than 500 banks to fail every year. From 1930 through 1933, over 1,000 banks failed per year with 4,000 banks failing in 1933 alone. The creation of the FDIC radically reduced the incidence of failed banks (the chart above begins in 1934).

Although the total number of banks/thrifts to fail in the 1980s and 1990s (dubbed the S&L Crisis) was greater than the Financial Crisis fallout (2007- 2014), the most recent crisis in the financial industry was far worse. Some of the largest banks failed and were bailed out/acquired versus mostly small banks in the ‘80s and ‘90s and the Federal Government had to pump trillions of dollars into the economy.

From a bank safety standpoint, the two major changes since 2008 have been 1) an enormous stockpiling of cash reserves by banks and 2) a significant tightening of lending standards.

Depository institutions (banks) hold capital at the Federal Reserve. Before the Financial Crisis of 2007-2009, banks held about $20 billion in reserve capital with the Fed. Lately, banks have held about $2.3 trillion at the Fed. This is an increase in capital reserves in the banking system of about 115x.

While banks have amassed huge cash reserves, they have simultaneously tightened their lending standards. The average FICO credit score to obtain a mortgage loan is now roughly 750, up from an average of about 680 during the housing boom years from 1996 through 2006.

On the commercial side, banks have migrated to larger/higher credit quality borrowers. Rating agencies S&P and Moody’s lowered their default rate estimates for high-yield corporate borrowers from 5.1% and 4.5%, respectively, to 3.9% and 3% for 2017.

Measured by capital reserves and tight lending standards, it appears there is a tremendous stockpile of liquidity available to fuel continued economic growth. Growth over time drives profits. Profits drive stock values. We end this week with a continuation of our bullish outlook for stocks.

One of the keys to investing is sifting through all available information and sticking to a plan. Somehow, we need to control our emotions about something that is very important to each of us. We invite you to call or email anytime if you have questions about how we can help you with your wealth management. Please give us a call at (415) 249-6337 or email us at info@uscapitalwm.com to learn more.
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Pursuant to the provisions of Rule 206(4)-1 of the Investment Advisors Act of 1940, we advise all readers to recognize that they should not assume that recommendations made in the future will be profitable or will equal the performance of past recommendations. This publication is not a solicitation to buy or offer to sell any of the securities listed or reviewed herein. The contents of this letter have been compiled from original and published sources believed to be reliable, but are not guaranteed as to accuracy or completeness. Nicholas Atkeson and Andrew Houghton are also principals of US Capital Wealth Management, a registered investment advisor. Clients of US Capital Wealth Management and individuals associated with US Capital Wealth Management may have positions in and may from time to time make purchases or sales of securities mentioned herein.

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